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Insolvency Series: Distressed Debt Units – Turnaround Turpitude?

16 May, 2018Keith Pond

If you borrow £1,000 and cannot pay it back – YOU have a problem. If you borrow £1 million and cannot pay it back – the BANK has a problem.

Banks have always used experienced and specialist managers to nurse fragile clients where bank losses in financial and reputational terms would be large should the client fail. Early references to the secretive “Lending Services Department” of Midland Bank were seen in David Wheatley’s article for Accountancy in 1983. Midland, always innovative, used seconded Insolvency professionals (which included David, himself) to strengthen the skill base. One of the Department’s biggest “clients” was the ill-fated Crocker Bank which it bought, disastrously, in a foray into the US market.

There is clear motivation for banks to invest time and even funding in cases where bank exposures are large:

Relationship strengthening, letting the client keep the umbrella when it starts to rain (Wheatley, 1983);

Bad debt reduction, shoring up the security and reducing the debt (Franks and Sussman, 2000);

Reputational benefit, where banks are seen to be pro-active in safeguarding jobs (Wheatley, 1983);

For smaller and medium-sized clients the resources and management strengths to overcome a crisis or to weather a stormy operating environment are much diminished. Whilst a reasonable reduction in bad debt or reduction of a debt shortfall may be possible –funding can switch from the bank to trade creditors (Franks and Sussman, 2000), the opportunities to raise service costs can be seen as damaging to the stricken client.

NOT only do SMEs offer slimmer pickings for the banking buzzard, but the scavenging of the carcass limits the positive benefits of reputational, regulatory and relationship motives.

Readers of this blog will know of the moral hazard that pervades many banking issues – and here is another. When selecting a bank to do business with how many borrowers do their due diligence on the “end game”? How many fail to realise that the same accommodating bank can become the worst of adversaries at the time when friendship is needed most?

REFERENCES:

Bank of England, (1996), The London Approach and trading in distressed debt, Bank of England Qtrly Bulletin, May.